Updated on April 18th, 2023
There are many reasons to buy out a business partner, including giving you complete control of the company. The steps for buying out a business partner include: 1) Determining the assets you’re buying, 2) Clear communication, 3) Hire an attorney and CPA, 4) Retain expert in business valuation, 5) Draft a partnership buyout agreement, 6) Determining buyout financing…
Brad Nakase, Attorney
Email | Call (888) 600-8654
Alex and Paul have together owned the computer software company LightWave for the past five years. While they have achieved a lot of success together, making the company one of the top businesses in their field, Alex makes a disturbing discovery. Thanks to an anonymous tip, he learns that Paul, his best friend of fifteen years, has been selling trade secrets to their biggest competitor. Heartbroken and angry, Alex feels he has no choice but to force Paul out of the business. He plans to buy out his partner, offering him money in exchange for his interest in the company. Unfortunately, when Alex speaks to Paul one-on-one about the issue, Paul is offended, denying the accusations. Alex decides to hire a mediator, who helps orchestrate the buyout, settling on an amount that Paul can agree to. Sadly, the discussions are so tense that Alex’s and Paul’s friendship cannot survive. Alex, however, carries on as LightWave’s owner.
Every business partnership must come to an end at one point or another. In fact, the majority of business partnerships conclude as the result of one of two reasons. The first of these is that one partner wishes to retire, move locations, or accept a new job offer. Therefore, he or she will not be able to assist the business in the same capacity. The second reason is that either one or both partners decide that it is no longer possible or best to work together.
Whatever the cause, if business partners make the decision to end their working relationship, but one wishes to still have control over the business, then it will be necessary to consider a partner buyout. The following list includes seven critical factors to keep in mind going forward with a buyout.
One of the key factors of a successful partner buyout is for both partners to remain on friendly, civil terms. It is important not to let emotion or drama stain the buyout process. While it is normal to feel anger or resent when splitting from a partner, it is neither helpful nor productive to make these feelings known publicly. It is best to approach one’s partner rationally and calmly, focusing on finding a solution that works for both individuals.
It is a good idea to iron out the details of the split with one’s partner in a face-to-face meeting. By first settling the matter one-on-one, both partners will be better prepared to speak with outside parties.
It is critical to seek common ground with one another. Perhaps a joint Memo of Understanding may be handed to representative. In this agreement, both partners agree on a solution and explain what each would prefer going forward. This practice of officially documenting one’s wishes makes the partner buyout run smoother, and with more professionalism.
That said, there can sometimes be too much anger or tension between partners to produce a meaningful conversation without the intervention of outsiders. In this situation, it would be wise to invite a mediator to help lead the discussion.
When planning a successful partner buyout, it is necessary to get the help of many different people, each serving a specific function. A partner should contact their accountant, banker, and attorney before jumping into any big decisions. An accountant can help prepare tax returns as well as other financial statements that are required to figure out the value of the seller’s equity interest. The accountant may also review some of the tax considerations involved in buying and selling. He or she may also assist in structuring the transaction to lessen the tax effects.
A banker can help a partner review options related to financing the buyout and managing funds throughout the buyout process. The company’s bank might also become involved in the funding of the purchase of the leaving party’s stock or equity interest.
An attorney can help inform a partner of the state’s laws affecting partner buyouts. He or she may also advise a partner in creating the terms of a buy and sell negotiation. This discussion may include details surrounding the price, the pay-out method, and possible non-compete clauses.
It may be a wise decision to hire an independent financial expert who may evaluate whether the business is in an acceptable position for a buyout. This expert will create a financial profile of the business to assess the fair market value of the departing owner’s interest. They conduct this analysis by studying the company’s balance sheet, expected profits, and the future cash flow of the business. This is because growth, cash flow, and risks drive the growth of a business, or determine its failure.
One of the benefits of bringing in a third party is the fact they may provide an objective eye. This objectivity will help ensure that the involved partners can come to fair and mutually beneficial buyout terms.
With all big moves in business there are significant risks involved. An owner of a business should be prepared to handle these issues when they arise. Therefore, he or she should take the time to isolate the greatest risk to their business if a partner sells.
Perhaps the departing owner is the key salesman for the company. With all the business contacts and relationship, he might take his portion of profit with him, leaving the business high and dry. Can the company continue to operate with his influence? Will many customers follow him to his next job, leaving the company with a smaller consumer base?
It is vital to anticipate these problems and understand the potential consequences of a buyout before proceeding with one. This way, an owner can come up with solutions with time to spare, such as creating a non-compete agreement. These solutions will help to prevent or reduce the likelihood of specific issues coming up.
It is important to maintain accurate and detailed records of all discussions that occur during the buyout process. These documents will form the basis of the buy and sell agreement. They will also help limit possible problems, such as lawsuits, down the road.
A partner should set clear terms when creating the buy and sell agreement, and he or she should also define each partner’s role, duties, and influence going forward. It is a good idea to watch the tone of the agreement, avoiding aggressive or petty language that may ruin the goodwill established between the partners. It is all too easy for negative language in a buy and sell agreement to lead to a lawsuit.
Depending on the financial health and state of one’s company, an owner may not be able to fund a buyout using cash on hand. Luckily, there are several ways to fund a partner buyout.
One method involves self-financing the buyout, which means that the owner would treat the leaving partner as a lender, paying him or her over a certain period of time, bit by bit. This is an effective strategy when the owner has a positive, healthy relationship with their business partner, as well as well-defined legal terms regarding the payment plan. If, however, the partnership is toxic, then it may not be advisable to extend the time spent involved with one another.
Another funding option involves applying for a business loan. This choice allows an owner to buy out his or her partner all at once, while still allowing the owner to pay off the amount in small pieces.
Blog: Business | Corporate | Employment Law
